Brussels today cleared the way for a dramatic shakeup of high street banking by formally approving the restructuring of Lloyds Banking Group, which will sell off 600 branches in return for state aid.

The bank, 43% owned by the taxpayer, can now press on with a record-breaking £21.5bn fundraising that includes a £13.5bn rights issue, again a record amount to raise from shareholders. The taxpayer will put in £5.7bn to support the sale of new shares by Lloyds.

The government hopes the sale of the branches will entice a new entrant to the high street alongside two other players created when Northern Rock is sold off and Royal Bank of Scotland disposes of 318 branches.

The City minister, Lord Myners, said: "With the bank now on a more secure footing, we can begin work to make sure Lloyds plays its part in reforming and repairing the banking system for the future.

"The divestments Lloyds will make following today's approval will lead to an important shakeup of the UK retail banking market. Together with divestments from RBS and the eventual sale of Northern Rock, consumers could have three new banks competing for their business on the high street within four years."

Neelie Kroes, the European Union competition commissioner, agreed: "The proposed divestments will create an entity with a market share of around 5% in the retail banking market, and a solid footing in mortgage and SME [small and medium-sized enterprise] markets. The new bank will have a good geographical spread and at least 600 branches. It's a great deal."

Kroes, who is yet to formally approve the application for RBS, said Lloyds would now "exit the riskier and more volatile lending activities in which HBOS had engaged in recent years".

"Their new focus will be core corporate and retail banking activities and applying Lloyds TSB's more prudent risk management methods. This will be a sound business model," Kroes said.

She said that the fundraising currently under way would "contribute to the bank paying for a significant proportion of the costs of restructuring".

"We support this capital-raising exercise as a solid alternative to the UK government's asset protection scheme, as it minimises taxpayer burdens. We ran a number of stress tests and concluded that this capital would see Lloyds through any unforeseen problems," she added.